In one of his famous “memos” released on May 8, renowned investor Howard Marks (Trades, Portfolio) discussed the impact debt can have on a company.
The paper, titled “The Impact of Debt,” began with Marks commenting on an article by Morgan Housel about the impact of debt on a company's longevity, which he noted “really boils down to a discussion of risk.”
He continued by explaining that people and companies that are indebted have a higher chance of encountering issues than those who are not. He wrote:
“Does that mean debt is a bad thing and should be avoided? Absolutely not. Rather, it's a matter of whether the amount of debt is appropriate relative to (a) the size of the overall enterprise and (b) the potential for fluctuations in the enterprise's profitability and asset value.
The guru went on to explain the reason for taking on debt, or leverage, is to increase capital efficiency. However, as with anything, there are advantages and disadvantages to doing so, which he also covered.
In his conclusion, he shared how to use debt prudently. He noted, “Using a moderate amount of borrowed capital balances the desire for enhanced gains against the awareness of the potential negative consequences.”
Read Marks' full memo here.
